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Gauging Institutional Interest and the Role of Regulated Investment Funds in a Post Crisis World

04 October 2011

Dominique Grandchamp, CFASenior Investment ConsultantMercer (Switzerland) SAdominique.grandchamp@mercer.com+41 22 918 10 15

2Mercer

Agenda

2) The Present - Where is the Performance?2) The Present - Where is the Performance?

3) The Future - How to invest in Hedge Funds?3) The Future - How to invest in Hedge Funds?

4) Ucits Hedge Funds Growth4) Ucits Hedge Funds Growth

1) The Past - Hedge Funds in a Less Regulated World1) The Past - Hedge Funds in a Less Regulated World

5) Conclusions5) Conclusions

3Mercer

The Past - Hedge Funds in a Less Regulated WorldWhat Hedge Funds Have to Do Better….

Black boxes (lack of transparency)

Operational and investment risks– Counterparty– Concentration– Leverage

Valuation independence

Liquidity mismatch

Remoteness and lack of regulation of offshore domiciles

Limited asset control and weak corporate governance

Stronger correlation with markets than advertised and expected

4Mercer

Agenda

2) The Present - Where is the Performance?2) The Present - Where is the Performance?

3) The Future - How to invest in Hedge Funds?3) The Future - How to invest in Hedge Funds?

4) Ucits Hedge Funds Growth4) Ucits Hedge Funds Growth

1) The Past - Hedge Funds in a Less Regulated World1) The Past - Hedge Funds in a Less Regulated World

5) Conclusions5) Conclusions

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The Present – Where is the Performance?Example: Switzerland’s Pension Fund System

Cash

Bonds35%

Equities

30%

Real Estate 20%

Commodities, HFs, PE

8% 7%

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The Present – Where is the Performance?Example: Performance last 10 years

Cash

Bonds

Equities

Real Estate

Alternatives

Liabilities

1%

4%

0%

3.5%5%

3%

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The Present – Where is the Performance?Example: Low Yield on Bonds

1.50

2.43

3.79

5.67

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Dec-

00

Dec-

01

Dec-

02

Dec-

03

Dec-

04

Dec-

05

Dec-

06

Dec-

07

Dec-

08

Dec-

09

Dec-

10

YT

M (

%)

SBI AAA-BBB Global Agg Global Agg Corp Global EM

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The Present – Where is the Performance?Challenges ahead…

Yield on bonds < Liability growth

Uncertain performance of equities coupled with high volatility

Look at more defensive, absolute return strategies

9Mercer

Agenda

2) The Present – Where is the Performance?2) The Present – Where is the Performance?

3) The Future – How to Invest in Hedge Funds?3) The Future – How to Invest in Hedge Funds?

4) Ucits Hedge Funds Growth4) Ucits Hedge Funds Growth

1) The Past - Hedge Funds in a Less Regulated World1) The Past - Hedge Funds in a Less Regulated World

5) Conclusions5) Conclusions

10Mercer

The Future – How to invest in Hedge Funds?Take into account Investor Expectations Post-2008

Liquidity

Transparency

Regulatory Oversight + Onshore Domiciles

Asset Control + Security

Tax Efficiency

Performance and preference for low volatility (defensiveness)

11Mercer

Embed defensiveness in the equity bucket…

… so as to reduce the overall risk

The Future – How to invest in Hedge Funds?Hedge Funds increase Defensiveness

Low Volatility

Small Cap

Broad market

strategies Emerging Markets

Defensive Strategies

SmallCap

IndexedEquities Emerging

Markets

Performance Drivers

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The Future – How to invest in Hedge Funds?Hedge Funds increase Defensiveness

Index-Strategies (MSCI World)

Beta =1

0 0.25 0.5 0.75 1 1.25 1.5

Beta

Beta > 1

• Emerging Markets

• Small CapsE

qu

ity

Str

ateg

ies

Beta < 1

• Minimum Variance-Strategies

• Quality +YieldStrategies

• Absolute Return

Strategies

Expand the in

vestable universe

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The Future – How to invest in Hedge Funds?Hedge Funds increase Defensiveness

Heuristic(Fundamental Indexing) Quality Strategies

Optimized(Minimum Volatility)

Absolute ReturnVariable Bias

DefensiveStrategies

IndexedStrategies

ActiveManagers

14Mercer

The Future – How to invest in Hedge Funds?Hedge Funds increase Defensiveness

CTAs

Global Macro

Relative Value

Long/Short Equity

Equities

15Mercer

Long-only Funds

Offshore Hedge Funds + FoFs

Onshore Hedge Funds(SIFs)

1 2

3

4 Mandates+Managed Account

Platforms

5Ucits Hedge Funds

6Indices+Replication

The Future – How to invest in Hedge Funds?Old and New Access Points

16Mercer

The Future – How to invest in Hedge Funds? The Great Convergence

Long-only Ucits IIIMandates

+ MacsOnshore HFs

(XIFs)Offshore HFs

Liquidity High High High Medium Low

Transparency Medium Medium High Medium Medium

Asset Control Medium Medium High Low Low

Tax Efficiency High High Low Medium Low

Low Beta Low Medium High High High

Regulatory oversight High High Low High Low

Benchmark awareness High Medium Low Low Low

Trend towards absolute returnIncreasingly benchmark-agnostic

Trend towards “onshorisation”Preference for liquidity and transparency

Long-only Ucits IIIManaged Accounts

Onshore HFs Offshore HFs

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The Future – How to invest in Hedge Funds?Which Access Point for Whom?

Banks

PensionPlans

Insurance

FamilyOffice

FATCA

LPCC UCIT

S

Solven

cy

AIFM

D

18Mercer

The Future – How to invest in Hedge Funds?Which Access Point for Whom?

Onshore, Ucits III Offshore HFs

Family Office Banks Insurance Pension Plans F,D,I,S,P Pension Plans CH, UK, Holland, Nordics

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The Future – How to invest in Hedge Funds?UCITS Drivers…

Factors which will drive the further development of Ucits Hedge Funds:

Wealth Management / Retail Distribution– Regulatory pressure– Search for tax efficiency– Distribution efficiency (Ucits IV)– Investor preference for liquidity

Institutional Investors– Regulation in some EU jurisdictions– Growing acceptance from early adopters– Search for yield, absolute return, defensiveness in liquid+regulated format– Size of investable universe (length of track record and AuM)

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The Future – How to invest in Hedge Funds?EU goes UCITS….

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The Future – How to invest in Hedge Funds?Who does not love UCITS???

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The Future – How to invest in Hedge Funds?Who loves UCITS???

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Agenda

2) The Present – Where is the Performance?2) The Present – Where is the Performance?

3) The Future – How to invest in Hedge Funds?3) The Future – How to invest in Hedge Funds?

4) Ucits Hedge Funds Growth4) Ucits Hedge Funds Growth

1) The Past - Hedge Funds in a Less Regulated World1) The Past - Hedge Funds in a Less Regulated World

5) Conclusions5) Conclusions

24Mercer

Ucits Hedge Funds Growth 750+ Ucits Hedge Funds Up and Running

# Funds # New Launches

Source: Absolute Return

25Mercer

Ucits Hedge Funds Growth120 Billion EUR AuM reached

Source: Absolute Return

26Mercer

Ucits Hedge Funds GrowthLength of Track Record

55%

30%

15%

Short (< 2y)

Medium (2-5y)

Long (>5y)

Length of track record (years)

27Mercer

Ucits Hedge Funds GrowthFund AuM (EUR)

< 50 MM 50%

50-200 MM 30%

> 200 MM 20%

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Ucits Hedge Funds GrowthRisks

Performance expectations of investors (less leverage + illiquidity)

Higher beta rather than alpha generation

High barriers to entry for entrepreneurial ventures

Counterparty risks and hidden fees (total return swaps)

Corporate governance issues remain (related parties + directors)

Regulatory oversight (NOT regulatory protection)

Lower due diligence standards applied by investors

29Mercer

Agenda

2) The Present – Where is the Performance?2) The Present – Where is the Performance?

3) The Future – How to invest in Hedge Funds?3) The Future – How to invest in Hedge Funds?

4) Ucits Hedge Funds Growth4) Ucits Hedge Funds Growth

1) The Past - Hedge Funds in a Less Regulated World1) The Past - Hedge Funds in a Less Regulated World

5) Conclusions5) Conclusions

30Mercer

Conclusions

Ucits and onshore Hedge Funds will continue to grow

Convergence with long-only products

Lower performance than in the past, defensiveness is welcome

Institutional interest is taking off in selected jurisdictions

Fund of Hedge Funds model challenged and struggling

Stick to a robust due diligence process

Traditional Hedge Funds remain to capture illiquidity premium

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Dominique Grandchamp

Mercer (Switzerland) SAAvenue Reverdil 8-10

1260 NyonSwitzerland

+41 22 918 10 15dominique.grandchamp@mercer.com

www.mercer.com